- The UK government has launched a £250 million rescue fund for startup founders whose businesses are struggling during the pandemic, but entrepreneurs are confused about whether they’ll be eligible.
- The £250 million Future Fund was launched in response to an industry campaign to save startups that might collapse. Its quick turnaround means the UK government has yet to publish the fine detail of how it will dole out the cash, who will qualify, and the terms of its loans.
- Critics of the fund say the current terms lack clarity and involve onerous terms of startups.
- But a source close to the Future Fund says startups can expect more clarity in the coming days.
- Visit Business Insider’s homepage for more stories.
UK founders hoping to stave off the collapse of their startups say a £250 million rescue scheme from the government is confusing, has onerous terms, and will ultimately only help a minority of firms survive the crisis.
The British government launched the £250 million Future Fund on April 19 as a backstop for startups facing ruin as COVID-19 puts a freeze on custom. The fund is due to spin up from mid-May, but as yet there are only preliminary details about how it will work.
While founders have welcomed the quick government response, they have reacted with dismay at the terms so far.
“There is a huge amount of ambiguity in the drafting,” said Hamish Grierson, CEO and cofounder of healthcare firm Thriva, describing them at face value terms as representing some of “the most egregious” on the market.
“Something is, of course, better than nothing,” he continued. “But for this particular financial instrument, I think there’s a serious question mark over whether its going to get the kind of uptake they’re expecting.”
How will the Future Fund work?
The £250 million fund will be handled by the state-backed British Business Bank. Startups will need to apply to the British Business Bank for the funding, and can obtain between £125,000 and £5 million which will take the form of a loan. But there’s another hurdle — in order to qualify, startups will also need to match the loan with private investment.
The loan will therefore comprise both government and private cash, and will automatically convert to equity on the startup’s next “qualifying” round of funding, at a valuation discount of 20% or higher.
But the devil is in the detail.
The government has published high-level terms but has yet to provide more detail on the application process and criteria.
Anthony Rose, a serial entrepreneur and chief executive of legal platform SeedLegals, published a critical post analyzing the scheme which was widely shared among UK entrepreneurs.
Among other concerns, he noted that a pot of £250 million isn’t going to stretch very far.
“Regardless of the rules, it’s not going to save your startup, it’s not enough money,” he told Business Insider. “My point is not that the scheme itself is bad, but to say it’s not going to be useful statistically for you.”
Here are some of the key questions on the Future Fund, and answers where we could obtain them:
1. It’s going to be logistically difficult to get funding
Although the Future Fund will be open for business in May, startups are still in the dark on how to go about applying.
For the taxpayer, a match funding approach makes sense. The government shouldn’t bail out risky startups — and their existing financial backers — with taxpayer cash. Match funding ensures the risk is shared between the taxpayer and the private sector, and practically may mean the private investor does most of the due diligence.
But it does create a headache for startups who must carefully time private investment with a successful Future Fund application.
“Let’s run through the mechanics,” said Rose. “Great, I qualify — do I now go to investors and get investors to sign this agreement? But then government may run out of money, because they only have £250 million. So now I’ve got signed term sheets with the investors, or do I get the government to sign first, then find the investors? I don’t get how the logistics will work.” (Rose’s solution is to automate the process through his own firm, SeedLegals).
Another logistical question is how the British Business Bank — already overwhelmed by the government’s separate emergency loans scheme — will cope with the influx of startup applications.
2. The scheme is not currently compatible with EIS/SEIS
A core plank of Rose’s criticism is that the Future Fund loan mechanism is incompatible with one of the most popular sources of capital for early-stage UK startups.
The seed enterprise investment scheme (SEIS) and enterprise investment scheme (EIS) are investment programmes that incentivize wealthy individuals to put their cash into startups. SEIS is for smaller firms, while EIS is for larger enterprises. An investor who puts £10,000 into a seed-stage startup can, if eligible, save £5,000 in income tax. According to HMRC, more than 2,000 companies raised a total of £190 million in 2019 under SEIS.
But the SEIS has its own restrictions, which makes it incompatible with the government’s loan note setup. “The way they set it up is just incompatible with SEIS and EIS,” said Rose.
HM Treasury did not respond to a request for comment.
But Business Insider confirmed with a source directly involved with the Future Fund that the scheme is incompatible with EIS and SEIS.
The problem, then, is that many of the seed-stage startups who would apply for Future Fund investment would also be turning to wealthy angel investors to match that cash. Those angels would likely turn the opportunity down if it doesn’t give them their tax break.
However, this may change. The Future Fund source said the industry was in active talks with the government on clarifying that the scheme is compliant with EIS. “The blunt reality is, it’s still under discussion,” the person said. “The intention was to be EIS-compliant.”
3. Startups must repay 2x the loan to investors — but our source denies this
One area of confusion is the terms of repayment and conversion into equity.
The Future Fund loan will mature after three years, but the expectation is that startups will raise a new round of funding before that. If the funding round qualifies, the loan will automatically convert into equity at at least a 20% discount and to the most senior class of shares.
If the startup doesn’t raise another round within three years and the loan matures, the funding will either convert to equity, or the loan must be repaid at 8% interest. The startup must also pay double the original loan amount.
Rose claims that the Future Fund’s terms mean private investors will be repaid double, but the government will only receive its original loan back. “For the government to come up with a condition that requires investors to get 2X their money back (but taxpayers get 1X their money back) is a shocker,” he wrote.
HM Treasury did not respond to a request for clarification.
However, the Future Fund source said while the government’s terms were badly drafted, it was not true that private investors would benefit versus the taxpayer.
“That’s incorrect,” the person said. “The whole point is that the terms for the government are the same as for private investors.”
4. The Future Fund loan may be incompatible with other types of debt
Melissa Morris, chief executive of Lantum, has been frantically trying to scale up projects to aid the NHS while also contending with furloughs. Lantum provides staffing software to healthcare organizations, and Morris says it has just rolled out its services across 500 GP clinics in Manchester.
While coping with an increase in demand, however, Morris has also tried to secure funding for her business. Lantum doesn’t qualify for the government’s initial tranche of rescue funding for businesses, CBIL, because it is loss-making. There was then a two-week gap before the Future Fund was announced.
“It was two weeks of lots of uncertainty in the business and we paused our funding round,” Morris said.
Without government support on the table, Lantum has furloughed staff in order to keep people employed. “Furloughs have been a success, it’s a great way to let you keep your staff and bounce back, but we also need our staff,” she said.
Having been burned by the CBIL rejection, she is wary of the Future Fund. According the Morris, a stipulation in the fund’s terms that the government takes the most senior class of shares on conversion may rule out any startups who have existing debt funding.
“The questions we have … the government wants to be the top-ranking loan note, so if you owe money to anyone else, they would rank above that,” she said. “We would have to negotiate with our venture debt provider, and I don’t know if they will allow anyone to rank above them.”
Venture debt, she added, was popular among founders who don’t want to give up a stake in their companies.
5. The government might sell off its stake in your startup without your say
One clause in the Future Fund states that the government can transfer its loan or the converted equity to any institutional investor looking to buy up stakes in at least ten Future Fund portfolio firms. It can also hand off its shares to any government department.
The Future Fund source acknowledged this was a continued area of concern, and said the industry was pushing back on the government to clarify.
As Rose put it: “The government can sell their ownership in your company to anyone they want, which could include selling a stake in your business to a fund with interests in a competitor of yours, or a fund that invests in fracking, etc.”
6. Some think the terms are unfair
Nii Cleland, cofounder and CEO of Flair Football, an app that lets young soccer players compare their little league stats, had just started fundraising for a seed round when the UK went into lockdown.
“It’s obviously far from an ideal time to be investing in startups, so I can understand why the term sheet looks so unfavorable … It’s definitely not the kind of thing you’d see in normal times,” he said.
“I’m hoping the government will change the criteria, so that it can adapt to the ways startups have already raised funds, rather than pushing out perfectly suitable companies that have done things in the more conventional way.”
Specifically, 8% interest on the loan, the 100% redemption premium, and the 20% conversion discount all make this an expensive option for startups.
Those who developed the Future Fund say this is government funding, provided at the last resort, so the strenuous terms aren’t particularly surprising.
7. The Fund could reinforce a lack of diversity
In a Medium post published last month, Deborah Okenla, founder and CEO of YSYS, which promotes diversity within the startup community, warned the government’s plans could put female and BAME entrepreneurs at a disadvantage.
In November last year, research from European VC firm Atomico confirmed suspicions that most entrepreneurs are well-off and well-educated before starting their companies.
The study, made up of interviews with 1,200 founders, found that 82% of founders had been to university, compared to 18% who hadn’t. The disparity was worse when looking at whether or not they had raised outside capital, with only 14% of founders without a degree managing to drum up investment.
The survey also found 84% of Europe’s tech bosses were white, compared to less than one percent of those identifying as black, African or Caribbean.
“[The Future Fund] will widen the gap between the founders who can attract capital, and those who can’t,” Lantum CEO Melissa Morris said. “It’s not always about how successful you are, it’s genuinely about discrimination.”
She added: “Will this end up being the new normal, will it widen the gap? I don’t know how they’ll balance it…I’m not sure if it’s something they’ll be able to address.”
A source close to the Future Fund agreed that diversity was an issue, but that if the government made the scheme compatible with SEIS and EIS, that may somewhat alleviate the problem.
8. The British Business Bank is overwhelmed
Finally, there’s the question of whether the British Business Bank will be able to cope with an influx of funding applications.
Last month, high street banks blamed the British Business Bank for the slow rollout of CBILS, the scheme put in place to help entrepreneurs get through COVID-19.
Banks choose which businesses they lend to, but have to book those loans with the business bank, which was appointed by the Treasury.
Banks across the country must follow the British Business Bank’s rules in order to qualify for the Treasury’s 80% guarantee of the money lend under the scheme.
But The Times reported that lenders had complained, saying the way loans are booked is too detailed and has led to a substantial backlog.
The Treasury has responded by trying to speed up the process, accrediting four new banks (Allied Irish Bank, ThinCats, Paragon Bank and Independent Growth Finance) as lenders, while looking at how automation could speed up the process.
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